The most hated market in the world

published 16 February 2012

What is the most hated market in the world right now?

It's certainly not the US. It's not China according to the latest Bank of America Merrill Lynch (BoAML) monthly fund manager survey, 86% of managers in the region believe the "Chinese economy is heading for a soft rather than hard landing".

It's not even Europe. As risk appetite picks up, managers have piled into the region's car manufacturers. They're even becoming less afraid of the banks.

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Which region could be so detested and so feared that it's even less popular than a continent that many would argue is on the verge of economic implosion?

Where else, but Japan?

Japan's biggest problem the yen

Here's a quote from February's BoAML fund manager survey. "Japan is now the least loved region in the survey for global fund managers, surpassing even the eurozone."

You can't blame them. Markets are already bored with Greece, after just two years of constant disappointment. Japan has spent the past two decades disappointing investors. It's a wonder it's still on the investment map at all.

Yet, it would be a mistake to ignore Japan. If you have any kind of reasonable time horizon before you plan to retire, then value investing buying cheap assets with the expectation that the market will eventually catch up strikes me as the most sensible strategy

And Japan certainly seems to offer value. It's as cheap as it's ever been. As James Ferguson noted in our Christmas roundtable (which you can read here: Sixteen investments that will prosper in 2012), the Topix index was recently as undervalued compared to corporate profits as it was overvalued at the peak of the bubble.

It's up around 10% since then, but most things have risen since then, so it's hardly unique in this. And that still leaves it looking very cheap.

But what's the catalyst to get the market moving?

Well, the main problem for Japan is the yen. It's too strong. It squeezes the country's exporters, who are vital to the health of the stock market. So what Japan could really do with is a weaker currency.

The Bank of Japan lacks credibility

Why is Japan stuck with such a strong currency in the first place? There are plenty of theories. But to me, the most obvious reason is that it is one of the only countries with a free-floating currency that isn't making a real effort to destroy its value.

Don't get me wrong Japan has printed plenty of money over the years. But it doesn't do it with the same unhinged relish that everyone else does.

In the US, Ben Bernanke has the markets convinced that he'd be pressing the print button every other day if he was only given free rein.

Over here, Mervyn King is even better. He couldn't give two hoots about the inflation rate. He prints money when he likes, and justifies it with a fan chart that suggests that inflation might just might be back below target by 2014.

The Swiss meanwhile, said they'd peg their currency to the euro at a set level. Everyone believed them. And they didn't really have to spend a thing defending that level, until the boss of their central bank the brains behind the policy was forced out of his job because of his wife's currency trading activities.

So this is one of those interesting areas in markets where it's all about credibility. In short, markets believe it when Ben and Merv say they want to wreck the dollar and the pound. They don't believe it of the Bank of Japan.

However, it looks as though this might change. The Japanese are clearly fed up with being the runners-up in the global currency wars. The country's exporters are becoming increasingly vocal for one thing.

And this week, the Bank of Japan finally adopted an inflation target. It now wants the consumer price index to rise at 1% a year. That doesn't sound like much, until you realise that prices in Japan are around 3% lower than they were in 2008. (It also promised to print another ten trillion yen).

Now, I'd quite like a bit of that kind of deflation over here I'm far from convinced that it's as bad a thing as everyone argues. But this is not the time and place for that debate.

The point is, the inflation target is significant. What it offers is a figleaf to justify more currency intervention. If other countries the US, say have the cheek to complain, then Japan can merely say it is trying to hit its official inflation target. It's no different, after all, to the Fed promising to print more money if inflation falls below its own official target of 2%.

Should you hedge your yen exposure?

You can hedge against a rising yen through various Japan funds. But the safest bet if you plan to invest in Japan for now is to leave your currency exposure unhedged.

Why? Because for one thing, the Bank of Japan is still fighting an uphill battle. The yen has weakened significantly in the past week or so, but if Greece goes bust, safe haven flows will rush back towards the currency.

So if the yen ends up getting even stronger, then at least, if you're unhedged, the gains in the currency help to offset the losses from the stock market. And if the yen does weaken sharply, then we reckon that the ensuing rush of enthusiasm for Japanese stocks would outweigh any loss on the currency side.

You can read more about this in my colleague Merryn Somerset Webb's recent interview with Martin Currie's John-Paul Temperley. John-Paul also gave us one of his favourite Japan tips.

And incidentally, the fact that everyone in the world is now cheerfully locked into battle to destroy their own currencies is also good for gold. But I think you know that by now.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.